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Monday, December 15, 2014

This week saw things take a turn for the worse for the faltering Periphery Bubble. On the back of crude's $8.03 collapse (to five-year lows), Venezuela CDS surged another 1,402 bps to 4,151 bps. Ukrainian bond yields surged 517 bps this week to 28.63%. Russian ruble yields jumped another 95 bps to 12.82%. On the currency front, the Russian ruble was slammed for another 9.25% (down 43.6% y-t-d). The Colombian peso fell 3.7%, the South African rand 2.1%, Indonesia rupiah 1.4%, Chilean peso 1.1% and Indian rupee declined 0.8%. The Chinese renminbi declined a not insignificant 0.6% against the dollar this week.

U.S. equities bulls are clinging to a sanguine view of collapsing oil and commodities prices. A well-known strategist was on CNBC late Friday afternoon espousing the bullish thesis, comparing the current backdrop to 1997, when the U.S. expansion soldiered on impervious to EM debacles and sinking commodities. Yet EM debt was miniscule then compared to now. Global debt was a fraction of today’s level. U.S. debt was about a third the current level. And, importantly, the amount of global leveraged speculation was a small fraction of that which surely inflates speculative markets these days. That said, the Russian collapse and LTCM debacle almost brought the global financial system down in October 1998.

Especially these days, “Core vs Periphery” analysis is as fascinating as it is challenging. As always, it’s as much an “art” as it is a “science.” Importantly, initial stress at the Periphery only tends to spur financial flows to the Core. Serious unfolding issues can go so far as to rejuvenate Core Bubble Dynamics. At some point, however, a profoundly consequential transformation begins to unfold: De-risking/de-leveraging (liquidity “vaporization”) actually begins to suck liquidity from even Core markets. Progressively more powerful contagion momentum at the Periphery is apt to jump what had seemed an impermeable fire wall (between Periphery and Core). This will manifest first, often subtly, at the Core’s periphery. Still, with bullishness having become so engrained throughout the Core marketplace, critical warning signals will be readily dismissed.

I believe Collapsing Bubbles at the Periphery have at this point attained irreversible momentum. And the further that crude, commodities and EM currencies fall, the less likely EM countries, corporations and financial institutions will have the wherewithal to service huge amounts of dollar-denominated debt. A critical issue to ponder today is to what extent higher-yielding dollar-denominated debt has been used as fodder for leveraged speculation – for so-called “carry trades” as well as in the proliferation of high-return derivative structures and products. This debt has also found a home in scores of funds that ballooned in size courtesy of central bank measures and an unmatched global yield chase. The amount of dollar-denominated EM debt and its widespread distribution are unprecedented. The associated risks (especially Credit and liquidity) seemed this week to begin resonating.

Back in the late-nineties, the emerging markets were referred to as “roach motels.” It’s always the case that funds flow so smoothly into EM markets and economies. And as long as flows spur domestic lending, booming securities markets, generally loose financial conditions and economic expansion, the dream can persist that EM policymakers and economic players have learned from previous fiascos. At the same time, I do sympathize with EM. Developed world policy ineptness helped to really, really bury them this time around.

It’s a harsh fact of life that “loose money” and attendant Credit and speculative Bubbles provide fertile breeding grounds for fraud and corruption (not even mentioning resource misallocation). Throw Trillions of cheap finance at “developing” financial and economic systems and you’ll at some point be dealing with major problems. And this is fundamental to the “global government finance Bubble” thesis: it’s been six years of history’s greatest and by far most dangerous Bubble. Now that Bubbles are Collapsing and the days of endless “hot money” inflows have turned to a rush for rapidly closing exits, some of the chicanery is coming into clearer view (i.e. Russia, Venezuela, Turkey, Brazil, Mexico, etc.). Just you wait for China.

It is also fundamental to my current analysis that central bank reflationary measures have rapidly lost their capacity to hold the global Bubble together. The wheels almost came off in October. Yet the efforts of Bullard, Draghi and Kuroda turned things around and incited yet another destabilizing speculative run. The market viewed that a Trillion from Draghi and another Trillion from Kuroda would more than offset the end of Federal Reserve liquidity creation. The game would continue.

The game, however, has changed. Flagrant euro and yen devaluation propelled king dollar, in the process giving a powerful bear hug to already deflating Periphery Bubbles. King dollar placed further downside pressure on crude and commodities markets. Collapsing oil and commodities impaired financial and economic stability for scores of countries and companies – too many that had ballooned debt (much dollar-denominated) throughout the previous boom. Huge amounts of global debt have rather suddenly turned suspect, inciting a self-reinforcing flight out of currencies, debt markets and commodities. And the more flows reverse out of the Periphery and head to the bubbling Core, the more destabilizing the unfolding king dollar dynamic for the global financial “system” and economy.

I’m sticking with my view of the existence of a massive “yen carry trade” (short a devaluing yen to leverage in higher-yielding instruments elsewhere). As was experienced during October’s bout of market instability - and as we saw at times again this week - any yen rally almost immediately fosters problematic de-risking/de-leveraging. And the assumption has been that as long as Kuroda remained at the helm, ongoing yen devaluation could be taken to the bank. This is reasonable and it may still play out this way. Indeed, the assumption of ongoing yen devaluation has been key to the resilient Bubble at the Core.

Yet, from the game aspect of it all, trading dynamics have undergone some subtle yet important changes. Nowadays, yen weakness powers king dollar – at the expense of Collapsing Periphery Bubbles. In a world where the Periphery and Core Bubble Dynamics have so profoundly diverged, no longer does yen devaluation keep the global Bubble afloat. And I think it’s reached the point where yen weakness has actually become destabilizing for the overall global Bubble. Yen devaluation works to sustain huge amounts of speculative leverage, but at the same time resulting dollar strength has pushed the unfolding EM collapse to the breaking point. This new dynamic provides a real policy quandary. Throwing more liquidity at the problem isn’t going to help.

The Fed released its Q3 2014 Z.1 “flow of funds” report this week. I won’t take as deep a dive as usual. From my perspective, what appears on the surface as a relatively benign Credit backdrop is in reality one with extraordinary vulnerability. I look out to 2015 and it is not clear how the system achieves ample Credit growth to sustain elevated securities markets, profit expectations and bullish optimism for the markets and real economy more generally - especially with ominous global storm clouds now gathering on the horizon.

Total Non-Financial Debt (TNFD) expanded at a 4.4% rate during Q3, up from Q2’s 3.4% and compared to Q3 2013’s 3.5%. Total Household debt expanded at a 2.7% rate, down from Q2’s 3.4%. And while Household Mortgage debt posted its first expansion in four quarters (0.7%), non-mortgage Consumer Credit slowed to a 6.4% pace, down from Q2’s 8.2% and Q1’s 6.6%. Total Business borrowings expanded at a 5.2% pace, up slightly from Q2’s 5.0% - but weaker than Q1’s 6.0%. State & Local government borrowing contracted at a 2.8% pace during Q3, more than reversing Q2’s 1.2% increase (which was the first positive number in five quarters). The star for the quarter, federal borrowings, expanded at a 7.2% annual pace, up significantly from Q2’s 2.5%.

In seasonally-adjusted and annualized rates (SAAR), TNFD expanded $1.801 TN, up from Q3’s $1.370 and Q1’s $1.688 TN. It was actually the strongest SAAR Credit growth since Q4 2012 ($1.962 TN). It is certainly worth noting that at SAAR $913bn, federal borrowings accounted for about half of TNFD. Household Debt expanded SAAR $366bn (mortgage $67bn and Consumer $206bn). Total Business borrowings expanded SAAR $605bn. State & Local contracted SAAR $84bn.

With equities under a little pressure during the period, Total Household Assets declined slightly in Q3 to $95.410 TN. And with Household Liabilities increasing $121bn (3.5% rate), Household Net Worth declined $141bn during the quarter to $81.349 TN. Over the past year, Household Assets increased $5.467 TN, with Net Worth inflating $5.140 TN. Net Worth was up a staggering $11.823 TN in two years and $26.664 TN in four years. As a percentage of GDP, Household Net Worth has increased from 331% to 463% in four years - to return almost to the record level from the end of 2007 (476%). There would be significant economic impact if Household Net Worth were to give back a few years of inflated gains.

I am fond of analysis that combines Treasury Securities, Municipal debt, GSE Securities, Corporate Bonds and Equities as a proxy for Total Marketable Securities (TMS). After beginning 1990 near $10 TN, TMS ended the nineties at about $33 TN. By the end of 2007, TMS had inflated to $52 TN. As a percentage of GDP, 2007’s 371% compared to 1990’s 178% (and 1999’s bubbly 355%).

TMS ended Q3 2014 at $70.79 TN, or 403% of GDP (both down slightly from Q2). TMS is now up $27 TN, or 62%, from the end of 2008. It is also worth noting that Equities at 200% of GDP surpasses 2007 (182%) and is almost back to 1999’s record 209%. And despite talk of system “deleveraging,” Total Debt Securities-to-GDP ended Q3 at 203%, up from 2007’s 182%, 1999’s 147% and 1989’s 114%.

One doesn’t have to go too crazy in search of cause and effect. The Federal Reserve’s Balance Sheet expanded SAAR $291bn during the quarter to a record $4.508 TN. Fed holdings jumped $720bn over the past year, or 19%. This puts the two-year open-ended QE operation (announced in the summer of 2012) at a staggering $1.700 TN, for 58.8% growth. It’s also worth noting that Security Credit jumped $189bn, or 16%, over the past year to a record $1.373 TN. Throughout the financial sector, no expansion is even remotely comparable to Federal Reserve and Security Credit.

Home mortgage borrowings expanded SAAR $77bn during Q3. This compares to 2005’s $1.128 TN, 2006’s $1.080 TN and 2007’s $771bn. Amazingly, six-years of ultra-loose monetary policy have done little to spur mortgage Credit expansion. And with Fed Credit growth supposedly ending and corporate Credit increasingly vulnerable to the forces of risk-aversion, mortgage Credit becomes only more critical to overall system Credit expansion. A strong case can be made that lowering market yields (and declining mortgage rates) no longer has much impact on mortgage borrowing (Household mortgage borrowings up 1.3% over the past two years!).

It is worth noting that GSE Securities expanded SAAR $225bn during Q3 (to $7.834 TN), up from Q2’s SAAR $185bn expansion. GSE Securities increased $240bn in 2013, the first growth since 2008. And with Fannie and Freddie now moving to lower lending standards, Washington appears ready for another push of GSE-induced Credit growth. As difficult as it is to believe, we’ll have to again keep close tabs on the GSE over coming quarters.

But the winner of the Q3 Z.1 Credit Sweepstakes goes to, once again, the U.S. Treasury. Treasury Securities expanded SAAR $914bn during the quarter to a record $12.756 TN. Over the past year, Treasury Securities increased $799bn, or 6.7%, with a two-year gain of $1.500 TN, or 13.3%. Since the end of 2007, outstanding Treasury Securities has increased $7.656 TN, or 150%. Over this period, total Household Debt declined about $420bn (to $13.414 TN). Tough to call this “deleveraging.”

Expanding upon comments made earlier, I think “ominous” when analyzing this Z.1. There is very little to indicate that an unprecedented expansion of Federal Reserve and Treasury Credit has resuscitated a private-sector Credit cycle. Corporate debt has expanded briskly over recent years, but even this important source of system Credit is now susceptible to both global and domestic forces.

My analytical hunch is that “hot money” flowing freely into our booming securities markets helps explain the robust asset price inflation backdrop in the face of lackluster underlying Credit dynamics. Thus far, troubles at the Global Bubble’s Periphery have ensured that king dollar flows inundate Core U.S. markets. But, again, there will be a point when Global de-risking/de-leveraging leads to waning risk-taking and liquidity – even at the susceptible Core.

I’ve argued for awhile now that the maladjusted U.S. economic structure requires in the neighborhood of $2.0 TN of annual non-financial Credit growth. The number for Q3 came in at $1.801 TN. System Credit has remained meaningfully below the $2.0 TN bogey since 2012. Yet I would argue strongly that the Fed’s massive QE program short-circuited typical dynamics. Miraculously, QE provided “money” for inflating securities prices, for ensuring ultra-loose corporate Credit conditions, for federal and state receipts, for corporate cash-flows and earnings, for record stock buybacks, for record M&A and for lots of spending (especially by the wealthy!). QE incited leveraged speculation and booming “hot money” flows. But QE has ended (for now).

I expect the post-QE landscape to be one of disappointing market performance, weakening corporate profits, less financial engineering and waning growth in government revenues (resurgent deficits!). I look out to 2015 and it’s not clear how we get anywhere near the $2.0 TN system Credit growth bogey. “Hot money” is the big wildcard. King dollar flows could help to sustain inflated securities markets, in the process inflating Household Net Worth (perceived wealth) and spending. But with my view that the global Bubble has burst, the probability for a problematic Risk-Off dynamic impacting the world has increased significantly. In that scenario, I don’t see the sources of sufficient liquidity and system Credit expansion to keep the U.S. Bubble markets and Bubble Economy levitated.

To summarize, six-years of unprecedented fiscal and monetary stimulus have ensured that everyone is today fully dressed up, liquored up, and silly eager for The Big Party. “Anybody seen the punchbowl?” “Where is it, and I mean now!” “Oh crap, where on earth did it go!!” “Who took it away!!” “I’m telling you to bring it back right now or there’s going to be some serious trouble!!!” What a fiasco.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $233bn y-o-y, or 2.0%, to another seven-month low $11.771 TN. Over two years, reserves were $924bn higher for 9% growth.

Money market fund assets rose $18.5bn to $2.706 TN. Money Funds were down $12.3bn y-t-d and $3.3bn from a year ago, or 0.1%.

Total Commercial Paper dropped $9.0bn to $1.087 TN. CP expanded $40.8bn year-to-date and was up $5.1bn over the past year, or 0.5%.

Currency Watch:

December 10 – Bloomberg (Fion Li): “Don’t fight the central bank is an old adage on Wall Street. In China, currency traders are doing the opposite. Traders pushed the yuan’s onshore exchange rate to a five- month low even as the People’s Bank of China raised the official rate to the highest since March. The 1% discount between the market and central bank rates is the widest gap since June. That’s a turnaround from the first four months of the year, when weaker fixings by the PBOC prompted speculators to reverse bets on yuan appreciation and sent the spot rate lower.”

The U.S. dollar index declined 1.1% to 88.36 (up 10.4% y-t-d). For the week on the upside, the Japanese yen increased 2.3%, the Swiss franc 1.6%, the Danish krone 1.5%, the euro 1.5%, the South Korean won 1.0%, the British pound 0.9%, the New Zealand dollar 0.9%, the Singapore dollar 0.7% and the Swedish krona 0.2%. For the week on the downside, the Mexican peso declined 2.7%, the Norwegian krone 2.6%, the Brazilian real 2.5%, the South African rand 2.1%, the Canadian dollar 1.3%, the Australian dollar 0.8% and the Taiwanese dollar 0.6%.

Commodities Watch:

December 10 – Bloomberg (Grant Smith): “OPEC cut the forecast for how much crude oil it will need to provide in 2015 to the lowest in 12 years amid surging U.S. shale supplies and reduced estimates for global consumption… The impact of this year’s 40% price collapse on supply and demand remains unclear, OPEC said.”

December 11 – Bloomberg (Christine Idzelis and Craig Torres): “The danger of stimulus-induced bubbles is starting to play out in the market for energy-company debt. Since early 2010, energy producers have raised $550 billion of new bonds and loans as the Federal Reserve held borrowing costs near zero, according to Deutsche Bank AG. With oil prices plunging, investors are questioning the ability of some issuers to meet their debt obligations. Research firm CreditSights Inc. predicts the default rate for energy junk bonds will double to 8% next year. ‘Anything that becomes a mania -- it ends badly,’ said Tim Gramatovich, who helps manage more than $800 million as chief investment officer of… Peritus Asset Management. ‘And this is a mania.’ The Fed’s decision to keep benchmark interest rates at record lows for six years has encouraged investors to funnel cash into speculative-grade securities to generate returns, raising concern that risks were being overlooked. A report from Moody’s… this week found that investor protections in corporate debt are at an all-time low, while average yields on junk bonds were recently lower than what investment-grade companies were paying before the credit crisis.”

December 12 – Bloomberg (Cordell Eddings and Nabila Ahmed): “The market for new junk bonds has all but shut as plunging oil prices and borrowing costs at an 18-month high deter issuers. Even as sales of high-yield, high-risk notes in the U.S. reached a record $353.1 billion this year, offerings have stalled this month with the slowest pace for a December since 2011. Junk is on track to deliver its second straight quarterly loss, the first time that’s happened since 2008, and trimming gains for the year to 1.47%... After six years of easy monetary policies by the Federal Reserve boosted the ability of the least-creditworthy companies to borrow on favorable terms, investors are becoming more discriminating. The average yield on speculative-grade debt climbed to 7.11% yesterday from an all-time low of 5.69% in June…”

December 9 – Bloomberg (Sridhar Natarajan): “BlackRock Inc. Chief Executive Office Laurence D. Fink said moments of severe volatility will continue to plague the corporate bond market unless regulators enforce a push toward more electronic trading. ‘Regulators need to admit that we have changed the ecosystem of bonds and yet we are not seeing regulatory pressure to transform the bond market into more electronic trading,’ Fink said… ‘I am absolutely convinced we will have a day, a week, two weeks where we will have a dysfunctional market. It’s going to create some sort of panic, create uncertainty again.’”

U.S. Bubble Watch:

December 12 – Bloomberg (Lisa Abramowicz): “Credit investors are preparing for the worst. They’re cleaning up their portfolios, selling riskier debt that’s harder to trade in bad times and hoarding longer-term government bonds that do best in souring markets. While investors have pruned energy-related holdings in particular as oil prices plunge, they’re also getting rid of other types of corporate bonds, causing yields to surge to the highest in more than a year. ‘We believe the pervasive nature of the sell-off is more reflective of overall liquidity concerns in the cash market than of fundamental deterioration,’ Barclays Plc analysts Jeffrey Meli and Bradley Rogoff wrote… ‘The weakness, while certainly most pronounced in the energy sector, has been broad based.’”

December 11 – Bloomberg (Lisa Abramowicz): “Perhaps 2014 will go down in history as the year that junk bonds sent a warning signal as oil plummeted and stocks just kept rallying. Prices on high-yield bonds have declined 2.4% this month and 5.7% since the end of August, even as U.S. equities have climbed to new highs. The dollar-denominated debt is now yielding the most relative to a comparable measure on the Standard & Poor’s 500 index since 2011.”

December 8 – CNBC (Phil LeBeau): “In the latest sign Americans are comfortable paying more for what they'll drive, the country is on the cusp of major milestone. This year, automakers are on pace to sell more than one million vehicles in the U.S. with transaction prices of at least $50,000 according to new data compiled by TrueCar… The growth in sales of higher priced models is stunning when compared with the auto industry overall. From January through November 931,064 vehicles were sold in the U.S. with average price above $50,000, a whopping 30.8% increase compared to the same period last year… Meanwhile, …sales of models with average transaction prices under $50,000 are up just 4.1% this year.”

December 8 – Bloomberg (Clea Benson): “Fannie Mae and Freddie Mac have set terms for letting borrowers put down as little as 3% of a home’s cost to get mortgages, a step criticized by Republican lawmakers as a return to risky lending. Starting on Dec. 13, Fannie Mae will allow the lower down payments for first-time homebuyers and permit refinancing borrowers to reduce equity to 3% to cover closing costs… Freddie Mac will begin a program in March giving breaks to lower-income buyers and first-time borrowers who get housing counseling.”

December 9 – Dow Jones (Jon Ostrower): “Boeing Co. will reduce monthly production of its 747-8 jetliner to 1.3 aircraft a month from 1.5, as demand continues to slow for the storied jumbo jet. The aerospace giant… said it would make the reduction, which will lower annual deliveries of the 747 to approximately 16 from 18, in September 2015. The planned cut enables ‘us to continue to run a healthy business,’ Boeing said… Boeing last year said it was cutting 747 output to 1.5 aircraft a month from 1.75.”

Federal Reserve Watch:

December 9 – Wall Street Journal (Jon Hilsenrath): “Federal Reserve officials are seriously considering an important shift in tone at their policy meeting next week: dropping an assurance that short-term interest rates will stay near zero for a ‘considerable time’ as they look more confidently toward rate increases around the middle of next year. Senior officials have hinted lately that they’re looking at dropping this closely watched interest-rate signal… ‘It’s clearer that we’re closer to getting rid of that than we were a few months ago,’ Fed Vice Chairman Stanley Fischer said… New York Fed President William Dudley has avoided using the ‘considerable time’ phrase in recent speeches and instead said the Fed should be ‘patient’ before raising rates.”

ECB Watch:

December 11 – Financial Times (Claire Jones): “The European Central Bank has injected €129.8bn through its second offer of cheap four-year loans, missing expectations of a higher take-up. Analysts polled by Bloomberg last week had forecast eurozone lenders to bid for €170bn of a possible €317bn. Banks took €82.6bn in the first of the auctions, which the ECB hopes will boost lending to the region’s credit-starved smaller businesses. The offer is part of a package of eight auctions, known as ‘Targeted Longer-Term Refinancing Operations’, allowing banks to borrow at ultra-low fixed rates if they agree to terms for lending to businesses and households in the region. The remaining six auctions will take place over the next two years. The result of the auction will weigh on the ECB’s decision-making in the months ahead, with weak demand supporting the case for doing more.”

Central Bank Watch:

December 11 – Bloomberg (Saleha Mohsin): “Norway’s central bank cut its main interest rate for the first time in more than two years and signaled it may ease again next year as plunging oil prices threaten growth in western Europe’s biggest crude exporter. The rate was lowered by 0.25 percentage point to 1.25%... The bank sees a ‘50-50 chance’ for another rate cut next year, Governor Oeystein Olsen said… The job now is to ‘prevent a severe downturn,’ he said…”

Russia/Ukraine Watch:

December 11 – Bloomberg (Olga Tanas, Anna Andrianova and Ksenia Galouchko): “Russia’s fifth interest-rate increase this year failed to stem the ruble’s worst rout in 16 years, risking further damage to an economy battered by sanctions and oil prices near the lowest since 2009. The Bank of Russia increased its key rate to 10.5% from 9.5%... ‘This is a spineless decision,’ Vadim Bit-Avragim, who helps oversee about $4 billion at Kapital Asset Management LLC in Moscow, said… ‘If the central bank’s goal was to defend the ruble, it would’ve raised rates by 2-3 percentage points.’”

December 10- Financial Times (Peter Spiegel in Brussels and Roman Olearchyk): “The International Monetary Fund has identified a $15bn shortfall in its bailout for war-torn Ukraine and warned western governments the gap will need to be filled within weeks to avoid financial collapse. The IMF’s calculations lay bare the perilous state of Ukraine’s economy and hint at the financial burden of propping up Kiev… The additional cash needed would come on top of the $17bn IMF rescue announced in April and due to last until 2016… ‘It’s not going to be easy,’ said one official involved in the talks. ‘There’s not that much money out there.’ …Without additional aid, Kiev would have to massively slash its budget or be forced to default on its sovereign debt obligations. Since the bailout programme began in April, Ukraine has received $8.2bn in funding from the IMF and other international creditors… Under IMF rules, the fund cannot distribute aid unless it has certainty a donor country can meet its financing obligations for the next 12 months, meaning the fund is unlikely to be able to send any additional cash to Kiev until the $15bn gap is closed. The scale of the problem became clearer last week after Ukraine’s central bank revealed its foreign currency reserves had dropped from $16.3bn in May to just $9bn in November. The data also showed the value of its gold reserves had dropped by nearly half over the same period.”

December 10 – Bloomberg (Lyubov Pronina and Natasha Doff): “Russian companies lost tens of billions of rubles on foreign-exchange derivatives amid a rout in the ruble, Interfax reported, citing Sergey Moiseev, the head of financial stability at the central bank. Companies were forced to close out the contracts after the central bank’s move to a free-floating currency exposed them to the world’s highest currency volatility amid a slump in oil prices, Moiseev said…”

December 11 – Bloomberg (Jason Corcoran, Ilya Khrennikov and Anna Baraulina): “Anatoly Ivanov, a 39-year-old software engineer who lives in a 53 square-meter (570 square-foot) St. Petersburg apartment with his wife and child, said he feels boxed in. The ruble’s collapse this year has caused a headache for Anatoly, who bought his Soviet-era home with a dollar mortgage in 2008… At the time, a dollar was 23 rubles and the interest rate on the mortgage was 4 percentage points lower than on loans in rubles. Yesterday, the rate was about 55 to the dollar, and Ivanov is considering paying a penalty to switch the mortgage into rubles. ‘Our $800 monthly payment has jumped to 38,000 rubles from 26,000 rubles since the start of the year,’ Ivanov, who is paid in rubles, said… Lured by foreign banks offering lower rates, Russians have taken 108.5 billion in non-ruble mortgage loans… While that represents 3% of total mortgages, 15% of the foreign currency home loans are delinquent, while 0.9% of ruble loans are overdue.”

Brazil Watch:

December 10 – Bloomberg (Filipe Pacheco): “Brazil’s plan to cut subsidized loans is coming at an inopportune time for corporate borrowers. Incoming Finance Minister Joaquim Levy pledged last month to scale back transfers to state development banks including BNDES, part of a strategy to trim debt levels after Standard & Poor’s lowered Brazil’s credit rating to the cusp of junk in March. While his plan reduced the nation’s funding costs in the bond market, it may also boost expenses for companies struggling to obtain overseas financing with yields at a 13-month high, Barclays Plc and Banco Mizuho do Brasil SA said. Levy’s strategy marks a shift after funding for BNDES doubled during President Dilma Rousseff’s first term, which benefited corporate borrowers including Petroleo Brasileiro SA, Norte Energia SA and Oi SA. Three Brazilian companies have pulled overseas bond offerings in the past month as economic growth stalls and a bribery probe into Petrobras prompts investors to shun sales.”

December 8 – Bloomberg (Julia Leite): “In 2011, Moody’s… rated Petroleo Brasileiro SA three levels above its owner, Brazil’s government. Today, the bond rater says the oil producer would merit a junk grade without state support and is proving a drag on the nation’s own creditworthiness. Mauro Leos, Moody’s lead analyst for Brazil, said… that a bribery probe into Petrobras is contributing to the negative outlook on Brazil’s rating, two days after Moody’s cut its so-called stand-alone rating for the oil producer to speculative grade. The comments came after the investigation took another turn last week when President Dilma Rousseff’s ruling party was alleged to have received donations from companies in exchange for securing contracts with Petrobras.”

December 8 – Bloomberg (Sabrina Valle): “AP Moeller-Maersk A/S is among foreign companies being investigated in Brazil over allegations they bribed Petroleo Brasileiro SA executives in exchange for contracts, widening the probe from local suppliers to companies working on oil projects around the globe. A prosecutor and a federal police agent said in interviews that they found evidence of international suppliers paying bribes through agents to Paulo Roberto Costa, the former Petrobras executive who is cooperating with authorities in exchange for a reduced sentence…”

December 11 – Bloomberg (Anna Edgerton and Rachel Gamarski): “Petroleo Brasileiro SA, the oil producer at the center of Brazil’s biggest-ever corruption scandal, plans to sell debt this year backed by the national treasury and state-run Centrais Eletricas Brasileiras SA. The transaction will be guaranteed by money that Eletrobras… owes Petrobras from the purchase of fuel for power plants, Energy Minister Edison Lobao told reporters…”

December 11 – Bloomberg (Francisco Marcelino, Gerson Freitas Jr. and Tariq Panja): “The boost that the World Cup was supposed to give Brazilian soccer hasn’t materialized as a sluggish economy and budget shortfalls leave the majority of top division clubs unable to pay salaries. Five of the league’s 20 clubs, including former FIFA world club champion Sao Paulo and Santos, where soccer star Pele spent the majority of his career, ended the season this month without major sponsors on their shirts. At least 17 clubs delayed players’ salaries this year, said a person with direct knowledge of the matter…”

EM Bubble Watch:

December 8 – Bloomberg (Srinivasan Sivabalan): “Foreign-debt levels of companies in emerging markets from China to India and Brazil are underestimated, threatening financial stability, the Bank for International Settlements said. Companies are raising more foreign funds through their offshore affiliates and accounting practices understate the currency risk in such transactions, the… institution said in its quarterly report. Almost half of the $554 billion that the firms raised in the five years through 2013 came from the affiliates, the BIS said. ‘Offshore subsidiaries of emerging-market non-financial corporates are increasingly acting as surrogate intermediaries,’ raising money abroad and transferring it to their parent companies, economists led by Stefan Avdjiev wrote. ‘This trend could have important financial-stability implications.”

December 11 – Financial Times (Pan Kwan): “Market fears over Venezuela’s creditworthiness are approaching panic levels as the price of oil plunges. The cost of insuring the South American country’s government debt against default surged to a new high on Wednesday… The five-year credit-default swap on Venezuelan government debt surged more than 832 bps — its biggest one-day jump on record — to 4019.57 bps. This makes Venezuelan debt the most expensive to insure in the world, surpassing even Argentina’s, which went into default for the eighth time in its history this year. The cost of insuring a portfolio of Venezuelan sovereign debt for five years against default has quadrupled since June, when oil began its downward spiral… With oil accounting for roughly 96 per cent of its export earnings and 48% of budget revenue, the slump in oil prices has taken a toll on the country’s already dire finances.”

December 9 – Bloomberg (Katia Porzecanski): “The scores of money managers and analysts who crowded into Cleary Gottlieb Steen & Hamilton LLP’s panel discussion on Venezuela last week are a testament to the deepening concern over whether President Nicolas Maduro can make good on the nation’s debt obligations. … Among the topics debated were whether the state oil company’s U.S. gasoline stations could be seized as collateral and whether it was legally possible for Venezuela to restructure the producer as an empty shell to avoid bondholder claims, they said. For a country that hasn’t missed a foreign bond payment in decades, the questions reflect growing speculation the socialist revolution that transformed Venezuela over the past 15 years under Hugo Chavez and now Maduro has finally pushed the nation to the brink of economic collapse.”

December 10 – Bloomberg (Onur Ant and Constantine Courcoulas): “Turkey’s economic growth slowed in the third quarter as falling borrowing costs failed to spur domestic demand and agricultural output contracted. Gross domestic product grew 1.7%, the slowest pace since 2012, compared with a revised 2.2% during the previous three months… Household consumption, which makes up two-thirds of the Turkish economy, grew 0.2% from a year ago compared with 0.5% during the previous quarter.”

December 12 – Bloomberg (Onur Ant): “Turkish central bank Governor Erdem Basci is sending monetary-policy signals that are upending a two-month government bond rally. Lira bonds have lost 3.8% in December after the biggest returns in emerging markets the previous two months… Further declines are in store after Basci indicated two days ago that he’s in no rush to cut interest rates further…”

December 9 – Bloomberg (Sandrine Rastello): “India’s current-account deficit widened more than estimated to the largest since the quarter through June 2013 as exports slowed and gold imports surged. The July-September shortfall in the broadest measure of trade widened to $10.1 billion from $7.8 billion the previous quarter… A recession in Japan and deteriorating outlook for the euro-area economy are keeping a lid on demand for Indian products as Prime Minister Narendra Modi seeks to revive manufacturing in Asia’s third-largest economy.”

December 9 – Bloomberg (Maciej Martewicz and Konrad Krasuski): “Poland’s real-estate developers are selling a record amount of debt this year to fund an office construction boom even as the central bank warns of a glut. Builders including Echo Investments SA and Ghelamco NV have issued about 1.7 billion zloty ($500 million) of bonds amid record low interest rates at home and in the neighboring euro region, according to Fitch… While the Polish central bank said last week that Warsaw vacancy rates at 14% signaled a ‘growing imbalance,’ no fewer than 46 office buildings, including the 48-story Warsaw Spire, are under construction.”

Europe Watch:

December 11 – Bloomberg (David Goodman): “Greece’s government bonds fell, pushing three- and five-year rates to the highest since the nation restructured its debt in 2012, amid speculation early presidential elections will spark renewed political turmoil. The nation’s 10-year yield exceeded 9% after Prime Minister Antonis Samaras said the markets fear a victory for anti-bailout party Syriza in potential elections next year.”

December 8 – Reuters (John O’Donnell and Paul Carrel): “The euro zone is experiencing a massive weakening in its economy not least due to a slowdown in its biggest member, Germany, a senior ECB policy maker said… ‘We see a massive weakening in the euro zone economy,’ Ewald Nowotny, a member of the ECB's Governing Council, told a conference… Nowotny said that the European Central Bank had struck a middle ground in its monetary policy, between extremes in the United States that called for full-blown money printing and others that wanted the ECB to take a less expansive path.”

December 10 – Reuters (James Mackenzie): “In a European political landscape increasingly populated with insurgent, anti-system parties, Italy's eurosceptic anti-immigrant Northern League is the latest to profit from a groundswell of hostility to the European Union. The League's 41-year-old leader, Matteo Salvini calls the euro a ‘criminal currency’ and wants to demolish the Brussels consensus that has dominated European politics since the end of World War Two. He is also, at odds with mainstream leaders, an admirer of Russian President Vladimir Putin. Salvini has become Italy's second-most popular leader since taking over the party, founded in the early 1990s as a separatist movement in the prosperous north of Italy.”

December 10 – Bloomberg (Sonia Sirletti): “Italian banks boosted their holdings of the country’s sovereign debt to a record high as Italy’s third recession in six years makes lending to companies and individuals risky. Italian banks increased Italian sovereign-debt holdings by almost 18.4 billion euros ($22.8bn) in October to a record 414.3 billion euros…”

December 8 – Bloomberg (David Goodman): “The drop in Italy’s 10-year bonds that followed a Standard & Poor’s downgrade of the nation lasted less than a morning, amid speculation the European Central Bank will start buying sovereign debt as soon as next month. Government bonds from Germany to Spain rose today after ECB President Mario Draghi said last week officials would act should current stimulus prove insufficient when it is reassessed early next year. A round of loans from the ECB to banks this week, part of stimulus plans intended to add as much as 1 trillion euros ($1.22 trillion) to the institution’s balance sheet, won’t even cover the repayments they owe from a previous program, according to a Bloomberg News survey…”

December 8 – Bloomberg (Ambereen Choudhury): “European banks will be weakened further by poor economic conditions and high litigation costs in 2015, according to Moody’s… Banks’ profits in the region, with the exception of the U.K. and Scandinavia, may be exposed to ‘economic tailwinds,’ hurting loan demand and the value of transactions, Moody’s said… ‘Weak macroeconomic conditions weigh on Europe’s banking sector, and low overall bottom lines implies that the European banking industry remains structurally vulnerable,’ Carola Schuler, Moody’s managing director…, said”

December 9 – Financial Times (John Plender): “France’s finance minister has called on the German establishment to watch its words when criticising his country’s economic policies, claiming barbs from Germany are fuelling the rise of anti-EU populists. Michel Sapin, who is under pressure from Brussels and Berlin to be more aggressive in cutting spending and in his reforms, said he was concerned by ‘certain extreme comments in Germany’. He called for mainstream parties to counter ‘outdated’ stereotypes.”

Global Bubble Watch:

December 8 – Financial Times (Claire Jones and Sam Fleming): “Global financial policy makers have sounded the alarm about the impact of a resurgent US dollar on emerging markets, where companies have racked up large debts denominated in the American currency. The Bank for International Settlements, known as the central bankers’ bank, warned… in its Quarterly Review that a prolonged rally in the dollar could expose financial vulnerabilities in emerging markets by damaging some companies’ creditworthiness. The… organisation added that there were increasing signs of fragility in financial markets, despite renewed hopes for economic growth, pointing to the recent stress in the $12.3tn US Treasury market that serves as the bedrock of the global financial system. ‘To my mind, these events underline the fragility — dare I say growing fragility — hidden beneath the markets’ buoyancy,’ said Claudio Borio, the head of the BIS’s monetary and economic department… However, companies in emerging markets have been borrowing heavily via the issuance of dollar securities in recent years… It said emerging market borrowers had issued a total of $2.6tn of international debt securities, of which three-quarters were denominated in dollars. International banks’ cross-border loans to emerging market economies amounted to $3.1tn in mid-2014, mainly in US dollars, the BIS added. Mr Borio said: ‘Should the US dollar, the dominant international currency, continue its ascent, this could expose currency and funding mismatches by raising debt burdens. The corresponding tightening of financial conditions could only worsen once interest rates in the US normalise.”

December 12 – Bloomberg (David Goodman): “The last time Greece’s bonds had this bad a week, the nation had just undergone the biggest debt restructuring in history, inconclusive elections had stoked concern it may exit the euro and Mario Draghi’s ‘whatever it takes’ pledge was more than two months away. The yield on Greek 10-year bonds has surged about 200 bps this week, the biggest leap since the height of the euro- area sovereign-debt crisis in May 2012. Worse still, the yield on three-year notes, issued in July as part of Greece’s emblematic return to capital markets, have jumped more than 450 bps, climbing above the longer-dated rates in a sign that investors are increasingly concerned the nation will be unable to pay its debt.”

December 8 – Reuters (Chris Vellacott): “China has become the largest emerging market destination for international bank lending, accounting for more than a quarter of cross-border claims on all emerging market economies, a central banking report shows. Cross-border claims on China increased by $65 billion in the second quarter of 2014 to $1.1 trillion, and were up nearly 50% in the year to the end of June, according to a quarterly report from the Bank for International Settlements… ‘China has become by far the largest (emerging market) borrower for BIS reporting banks. Outstanding cross-border claims on residents of China totaled $1.1 trillion at end-June 2014, compared with $311 billion on Brazil and slightly more than $200 billion each on India and Korea,’ the report says.”

Geopolitical Watch:

December 12 – Bloomberg (Diep Ngoc Pham and John Boudreau): “Tensions over the South China Sea were reignited after Vietnam said it had submitted its stance on the dispute to the international arbitration tribunal reviewing the Philippines’ challenge against China’s claims. Vietnam has asked the arbitration court to take into account its legal rights and interests in the disputed sea region, spokesman Le Hai Binh, said… The country also refuted China’s claims to the Paracel and Spratly islands in the statement, which provoked a Chinese response yesterday that its neighbor’s claims were unlawful. The renewed tensions are being sparked as the United Nations tribunal in the Hague considers Philippine’s challenge to China’s claim to much of the South China Sea as the island nation seeks to check Beijing’s bid for control of waters rich in oil, gas and fish. Vietnamese and Philippine leaders say they are determined to oppose China’s move to control the sea region…”

December 12 – Bloomberg (Alex Nussbaum and Alex Morales): “Envoys at the United Nations climate talks enter their final day in Lima divided on how to put teeth into a deal that the biggest polluters have turned into a package of mostly voluntary measures. Developing countries led by China and India want to pin down industrial nations on how they’ll meet a pledge for $100 billion a year in climate-related aid by 2020. The U.S. and its allies want to secure a way to ensure that all governments, rich and poor alike, will curb greenhouse gases. The differing goals underscore how quickly the problem about how to rein in emissions has shifted from an issue aimed mostly at rich polluters into one that needs to be answered by all nations.”

China Bubble Watch:

December 11 – Reuters: “China has told its banks to lend more in the final months of 2014 and relaxed enforcement of loan-to-deposit ratios to expand credit, sources told Reuters… Figures on inflation, imports and fiscal spending in November have already undershot expectations since the People's Bank of China (PBOC) sprang a surprise interest rate cut on Nov. 21… ‘I wouldn't be surprised by that at all,’ said Andrew Polk, resident economist for the Conference Board in Beijing. ‘It seems pretty clear activity is continuing to weaken throughout this fourth quarter.’ Two sources with knowledge of the matter said China's central bank increased the annual new loan target to 10 trillion yuan ($1.62 trillion) for 2014, up from what Chinese media have said was a previous target of 9.5 trillion yuan. Banks have disbursed 8.23 trillion yuan of loans between January and October, so they will have to quicken the pace in the last two months if they are to meet the new target.”

December 9 – Bloomberg: “China took one of its biggest steps yet to push local governments away from using opaque financing vehicles to raise money as policy makers seek to reduce leverage and develop a more transparent municipal bond market. The nation’s clearing agency for exchanges said yesterday it won’t allow bonds rated below AAA or sold by issuers graded lower than AA to be used as collateral for short-term loans obtained through repurchase agreements. The new rules sparked a retreat in lower-rated bonds of local government financing vehicles and contributed to a tumble in Shanghai shares as noteholders reassessed the appeal of owning such debt.”

December 12 – Bloomberg: “A local government financing vehicle in China’s eastern province of Jiangsu has delayed a bond sale after authorities ruled it wouldn’t be backed by the state. Changzhou Tianning Construction Development Co. said it won’t go ahead with a 1.2 billion yuan ($194 million) offering planned for Dec. 15 because of market volatility… The Finance Ministry has said local governments must detail all outstanding borrowings by Jan. 5 as it determines which of the thousands of financial entities set up by cities and provinces it may be willing to support.”

December 11 – Bloomberg: “The People’s Bank of China injected 400 billion yuan ($65bn) into the banking system, according to a person familiar with the matter, pressing ahead with targeted steps to add liquidity as the economy slows… The move comes as a previous PBOC injection of 500 billion yuan comes due this month. The PBOC had said it pumped that amount into the economy in September with a term of three months and a rate of 3.5%. Another 269.5 billion was added in October with the same terms, it said.”

December 10 – Bloomberg: “With $90 billion of bonds sold by local government financing vehicles coming due next year, China is walking a fine line between teaching investors a lesson and preventing widespread defaults. The nation’s clearing agency said this week that local bonds rated lower than the highest AAA grade are too risky to be used as collateral for short-term loans. That means about half of the outstanding 1 trillion yuan ($162bn) securities sold by local government financing vehicles, or LGFVs, in the exchange market can no longer be pledged to raise funds, according to Morgan Stanley. Warning that these securities aren’t risk free caused the yield spread on seven-year AA-rated local debt over Chinese government bonds to widen the most on record yesterday. Now investors will be looking for clues as to which of the thousands of financial entities set up by cities and provinces the government may be willing to support, and which it won’t. ‘We could see a further sell-off in LGFV and corporate bonds as investors are more aware of the credit and liquidity risks,’ said Ken Hu, the… chief investment officer for Asia-Pacific fixed income at Invesco… ‘The new rules are leading to some large-scale deleveraging.’”

December 11 – Bloomberg: “Loan defaults at China’s state-owned enterprises may increase as growth in the world’s second-biggest economy slows, according to Moody’s… Risks are greatest in industries with excess production capacity, Kai Hu, a senior credit officer at the rating company, said… Regulators stepped up efforts to curb local-government debt on Dec. 8, prompting borrowing costs to jump and companies to cancel or postpone at least 46.6 billion yuan ($7.5bn) of note sales this week… In the latest signs of concern in China’s credit markets, the extra yield companies rated AA must pay to sell bonds due in seven years over similar-maturity government notes has surged 51 bps this week to a two-month high of 263 bps. The seven-day repurchase rate, a gauge of interbank funding availability, rose as much as 17 bps today to a four- month high of 3.81%...”

December 6 – Financial Times (Jamil Anderlini): “China’s previously overheated property market has been in the doldrums for most of this year but things are likely to get a lot worse, because of demographic shifts that are about to reverse a main driver of the decades-long boom. According to newly published research, the size of China’s main property-buying population — people aged 25 to 49 — will peak next year and then start to decline, just as a huge glut of new apartments hits the market. This demographic will shrink drastically from 2018, with the number of urban homebuying Chinese falling much faster than contemporaries from the countryside, who are far less likely to have the means to buy expensive apartments, according to Ai Jingwei, an expert on Chinese real estate and author of the research… Moody’s Analytics estimates the building, sale and outfitting of apartments accounted for 23% of Chinese gross domestic product last year.”

December 12 – Bloomberg: “China’s economy slowed in November as factory shutdowns exacerbated weaker demand, raising pressure on the central bank to add further stimulus. Bloomberg’s gross domestic product tracker came in at 6.78% year-on-year in November, down from 6.91% in October and a fourth month below 7%... Factory production rose 7.2% from a year earlier, retail sales gained 11.7%, and investment in fixed assets expanded 15.8% in January through November from a year earlier…”

December 10 - South China Morning Post (Phoenix Kwong): “Economic weakness continues to weigh on China auto sales growth, which slowed to 2.3% last month. Vehicles sales last month totalled 2.1 million units, with the year-on-year growth rate slowing from October’s 2.8%, the state-backed China Association of Automobile Manufacturers (CAAM) said… November’s growth rate was 7.4 percentage points lower than that of the same period of last year, it said.”

December 12 – Bloomberg: “China plans to establish a fund to support troubled trust firms as repayment risks accumulate in the 13 trillion yuan ($2.1 trillion) industry. Under rules jointly issued by China Banking Regulatory Commission and the Ministry of Finance, each trust firm is required to contribute 1% of their net assets to the fund, while each trust product will pay 1% of the money raised… Premier Li Keqiang is trying to sustain economic growth while containing financial stress after the nation’s loosely regulated shadow-banking system started swelling in 2010.”

December 9 – Bloomberg: “China’s residential building boom is petering out, with the effects seen from slumping steel and cement prices, to electricity use, rail-freight traffic and retail sales. The drag will be long lasting with home completions set to fall by 1 to 3% annually from next year to 2025 after almost tripling in 13 years, according to… Gavekal Dragonomics. A once-in-a-generation shift in demand for housing and an overhang of supply suggests policy makers can cushion the effect with interest-rate cuts such as the one announced Nov. 21, not reverse it. ‘The turning point has come,’ said Wang Tao, chief China economist at UBS… ‘Construction has to come down so that means growth has to slow, and therefore steel demand, cement demand, energy consumption, mining production, appliances, automobiles -- everything has to come down.’ …Increasing evidence the slowdown is structural, not cyclical, is playing out on commodity markets and leaves the U.S. shouldering prospects for a pickup in 2015 global growth.”

December 12 – Bloomberg (Toru Fujioka and Masahiro Hidaka): “The Bank of Japan rejects the idea that additional monetary stimulus is needed to prevent the decline in oil prices in recent months from pulling down inflation, according to people familiar with the discussions. For now, policy makers assess that while cheaper energy costs may weigh on consumer prices for a time, they ultimately will boost the economy -- spurring inflation, the people said… Less agreement is found on how much capacity the central bank has to expand its buying of government debt, some of the people said.”

Let’s begin with a brief update on the worsening travails at the Periphery. The Russian ruble sank another 6.5% this week, increasing y-t-d losses to 37.9%. Russian yields surged higher. Russian (ruble) 10-year yields jumped another 146 bps this week to 12.07%, with a nine-session jump of 188 bps. Russian yields are now up 425 bps in 2014 to the highest level since 2009.

Increasingly, EM contagion is enveloping Latin America. The Mexican peso was hit for 1.6% Friday, boosting this EM darling’s loss for the week to a notable 3.0%. This week saw the Colombian peso hit for 4.3%, the Peruvian new sol 1.1%, the Brazilian real 0.9% and the Chilean peso 0.6%. Venezuela CDS (Credit default swaps) surged 425 bps to a record 2,717 bps. Venezuela CDS traded near 1,000 in August. On the bond front, 10-year yields jumped 30 bps this week in Brazil, 24 bps in Mexico and 24 bps in Colombia. Brazilian stocks were slammed for 5% this week and Mexican equities fell 2.2%.

Eastern European currencies were also under pressure. The Ukrainian kryvnia dropped 2.9%, the Romanian leu 1.5%, the Bulgarian lev 1.3%, the Czech koruna 1.3%, the Hungarian forint 1.1% and the Polish zloty 0.7%. The Turkish lira was hit for 1.9%, as 10-year yields jumped 33 bps to 7.91%. The South African rand dropped 2.6% to a six-year low. In Asia, the Malaysian ringgit dropped 2.5%, the Singapore dollar fell 1.4% and the Indonesian rupiah declined 0.8%.

Declining 1.3%, the Goldman Sachs Commodities Index fell to the low since June 2010. Crude traded to a new five-year low. Sugar fell to a five-year low, with coffee, hogs and cattle prices all hit this week.

And a quick look at the bubbling Core: The Dow 18,000 party hats were ready, although they will have to wait until next week. The S&P500 traded Friday to another all-time record. Semiconductor (SOX) and Biotech (BTK) year-to-date gains increased to 31.4% and 48.1%, respectively. The week also saw $4.0 Trillion of year-to-date global corporate debt issuance, an all-time record. Italian (1.98%), Spanish (1.83%) and Portuguese (2.75%) yields traded to all-time record lows again this week.

December 4 – Bloomberg (Sree Vidya Bhaktavatsalam): “Bill Gross… recommended that investors reduce risk and prepare for asset prices to stop increasing… Gross… suggested that the creation of more debt by policy makers worldwide to solve the credit crisis will be judged by future generations much like smoking in public or discrimination against gays is viewed by people today… ‘Can a debt crisis be cured with more debt?,’ Gross wrote. ‘I suspect future generations will be asking current policy makers the same thing that many of us now ask about public smoking, or discrimination against gays, or any other wrong turn in the process of being righted… How could they? … How could policymakers have allowed so much debt to be created in the first place, and then failed to regulate their own system accordingly? How could they have thought that money printing and debt creation could create wealth instead of just more and more debt?”

I appreciate Bill Gross’ December commentary, “How Could They?” This period will be really difficult to explain to future generations. It’s rather challenging to explain in real time. I’ll dive deeper into the question, “Can a debt crisis be cured with more debt?”

The problem, as we’ve witnessed in the past, is that debt crises have been “cured.” So I would posit that the dilemma associated with reflations is that they do seem to work for a while – perhaps even for a long while – almost miraculously. This naturally bolsters policymaker self-confidence, market confidence in policymaking and confidence in “Keynesian” governmental management more generally. It becomes too easy for everyone to disregard Bubble risks.

The early-nineties debt crisis that followed late-eighties “decade of greed” excess? Well, inflated away with more debt. The S&L fiasco? Right. Inflated away with a major ramp-up of debt growth in the nineties. The 2001/02 debt crisis after the collapse of late-nineties (“technology Bubble”) excess? Melted away like magic through the great inflation of mortgage Credit. And the debt crisis subsequent to the collapse of the mortgage finance Bubble? Inflated away with protracted “global government finance Bubble” Credit excess.

Agreeing with Mr. Gross, I do believe we’re approaching the end of the reflation “miracle”. To build my case, I’ll focus again on Financial Sphere Versus Real Economy Sphere Analysis. It is fundamental to my Credit Bubble Thesis that the (desperate) global central bank reflationary push is mainly inflating the Financial Sphere. This reflation has unfolded primarily through central bank Credit, sovereign and corporate debt, and global securities markets. Especially over the past two years, there is support for the view that it's only a myth that central banks control and can readily manipulate a general price level (in the real economy).

A Bank of Japan (BOJ) board member, Takehiro Sato, Friday made a pertinent comment (quoted by WSJ): “Prices reflect the temperature of the economy, not a variable that can be directly controlled by a central bank.” Japan’s 25-year experience offers the best proof that even massive government fiscal and monetary stimulus does not ensure the ability to inflate out of debt problems.

Real economy pricing dynamics – especially in contemporary globalized economies – are highly complex. The massive increase in manufacturing capacity associated with globalization has placed downward pressure on many prices. Virtually unlimited cheap finance on a global basis has over recent years certainly spurred unprecedented capital investment. And, importantly, ongoing technological innovation and the “digital age” have played a momentous role in creating essentially limitless supplies of smart phones, tablets, computers, digital downloads, media and “technology” more generally. Throw in the growth in myriad “services,” including healthcare, and we have economic structures unlike anything in the past. History will look back and see this as all rather obvious. Today, central bankers ignore the reality that reflationary measures confront insurmountable headwinds in the Real Economy Sphere.

The Bernanke-inspired global central bank experiment is mindlessly fixated on dropping “helicopter money” directly into the Financial Sphere. The expectation has been that rising securities prices and “wealth” creation would feed through to the real economy – in the process spurring borrowing, spending and real investment sufficient to inflate the system out of its debt and structural woes.

“Can a debt crisis be cured with more debt?” Well, I would strongly suggest that if policy-induced debt expansion unfolds predominantly in the realm of the Financial Sphere, there’s a major, major problem. If prevailing effects include rampant speculative leveraging, it will work too well to inflate Bubbles only to later return to haunt system financial and economic stability. I would further argue that an expansion of non-productive debt, while short-term stimulatory, is also deleterious for financial and economic systems. Trillions of new government borrowings financing consumption – debt expansion unlikely to be reversed - is asking for long-term problems. I also believe strongly that Financial Sphere inflations are essentially wealth redistributions, ensuring that daunting economic and social problems come to create powerful headwinds for real economies.

What differentiates today’s reflation from those that “worked” in the past? The current reflation has overwhelming manifested within the Financial Sphere. And that’s the essence of why I believe the Bubble is now running on borrowed time. It’s a critical issue that goes completely unrecognized these days: In the end, Financial Sphere inflations are unsustainable.

The crucial vulnerability lies within the murky world of Risk Intermediation. Financial Sphere expansions inflate myriad market risks – including price, Credit, interest-rate, liquidity and, more generally, Bubble risks. From my perspective, the global government finance Bubble is in the late stages because of the acute fragility associated with mounting Financial Sphere risks. Especially since the summer of 2012, global central bankers have been in a desperate struggle to sustain Financial Sphere Bubbles. Yet the most significant consequence has been the widening divergence between deteriorating global economic prospects and escalating securities market risks.

Aggressive/reckless Risk Intermediation played a fundamental role throughout the fateful post-tech Bubble reflation. The GSE’s, the securitization marketplace and derivatives were instrumental to the “Wall Street Alchemy” that transformed Trillions of risky mortgage Credit into perceived safe and liquid “money-like” instruments. The “Moneyness of Credit” was essential for the doubling of mortgage Credit in just over six years. It amounted to a historic episode of risk and market distortions. Moreover, as the cycle lengthened and risk escalated, the Risk Intermediation task fell increasingly to the toxic combination of CDO/derivatives markets and leveraged speculation.

Credit, speculation and (financial and economic) resource misallocation facets of the Bubble guaranteed that collapse was unavoidable. The widening gulf between the perception of “moneyness” and the deteriorating quality of the underlying instruments was unsustainable. Importantly, policy stimulus only prolonged the “Terminal Phase” parabolic rise of systemic risk. Late-cycle Financial Sphere distortions ensured a misallocation of resources in the real economy that came back to undermine system stability when the Bubble burst. When waning confidence in the underlying Credit finally impinged Credit Availability, the system’s inability to sustain rapid Credit growth ushered in the cycle’s downside.

Today, the “Moneyness of Risk Assets” is the critical Bubble and Risk Intermediation issue. To be sure, Fed and global central bank liquidity injections, backstops and assurances have created epic market distortions that dwarf those from the mortgage finance Bubble. The entire world believes central bankers will support stock, bond and asset prices. Everyone believes central bankers will ensure liquid markets. Most believe global policymakers will forestall financial and economic crisis for years to come. And it is these beliefs that account for record securities prices in the face of a disconcerting world.

There are all kinds of serious issues related to a six-year period of near zero rates, massive liquidity injections and central bank market support (all on a global basis). I would argue that global fixed income has undergone historic risk mispricing – which is especially problematic considering the record $4.0 TN of global corporate debt issued this year. Tens of Trillions of suspect sovereign debt have been grossly mispriced. And especially with an increasingly disinflationary backdrop taking hold throughout the global Real Economy Sphere, there is (unappreciated) parabolic growth in Credit risk way beyond even the late-stage of the mortgage finance Bubble.

To be sure, the gulf between the perceptions of “Moneyness” and mounting global Credit risk grows by the week. It’s worth noting that debt from Argentina, Venezuela, Ukraine, Russia, Brazil and the energy-sector provide a reminder of how abruptly market adjustments can unfold. There are ominous parallels between this year’s faltering Periphery and subprime 2007.

I worry a lot about global Credit risk. I worry more about illiquidity. Financial Sphere inflation, heavy risk intermediation and the “Moneyness of Risk Assets” combine to nurture historic market liquidity risks. To be sure, six years of zero rates (along with repeated market interventions) ensured that Trillions flowed into various funds and products perceived as highly liquid stores of wealth (“money-like”). Wall Street – and especially the ETF complex – has fashioned scores of perceived liquid low-risk products that invest in illiquid underlying instruments (stocks, corporate debt, municipal debt, EM, etc.). “Money” continues to flood into stock index funds and products, with the perception that these types of vehicles are low-risk and highly liquid (courtesy of the Fed).

This serious marketplace liquidity risk problem began to manifest in 2012, then again in the spring of 2013 and once more this past October. Each episode was met quickly by aggressive central bank liquidity measures and assurances. Each market rescue further emboldened risk-taking and leveraging. In the process, the gulf between the perception of “moneyness” and escalating liquidity risk grew only wider.

Right here we can identify a key systemic weak link: Market pricing and bullish perceptions have diverged profoundly both from underlying risk (i.e. Credit, liquidity, market pricing, policymaking, etc.) and diminishing Real Economy prospects. And now, with a full-fledged securities market mania inflating the Financial Sphere, it has become impossible for central banks to narrow the gap between the financial Bubbles and (disinflationary) real economies. More stimulus measures only feed the Bubble and prolong parabolic (“Terminal Phase”) increases in systemic risk. In short, central bankers these days are trapped in policies that primarily inflate risk. The old reflation game no longer works.

It’s also worth noting that Friday’s jobs data confirm that the Fed has fallen far behind the curve. Benefiting much of the U.S. economy short-term, trouble at the Periphery of the global Bubble has seen financial conditions loosen at the Core (rising securities prices, lower mortgage and corporate borrowing costs, etc.). King dollar is increasingly destabilizing, spurring “hot money” away from the faltering Periphery and to the inflating U.S. Bubble. Bubble excess beckons for Fed tightening, though they will surely be fearful of further elevating king dollar and upsetting highly unstable markets.

There are reasons why central bankers and central banks have a long history of conservatism. Risks are much too great for experimentation – experiments in “money,” loose Credit and aggressive stimulus. History has shown unequivocally that you don’t want to monkey with money and Credit. Central banks monkey with securities and asset markets at all of our peril.

We now see all the world’s major central banks trapped in a monetary experiment run amuck. Not surprisingly, especially considering the length and results from prolonged monetary stimulus, deep divisions have developed within the central banker ranks. This week saw more public policy criticism from past and present members of the Bank of Japan. There is also this deepening rift between Draghi and the Germans. Draghi continues to talk tough and assure the markets he’s ready for QE, with or without German consent, surely believing they will have no choice but to come around. The Germans believe “monetary financing” is illegal. Draghi counters that it would be “illegal” if the ECB did not pursue its 2% inflation mandate. How this plays out has major ramifications for the global Bubble.

I’ll conclude with more wisdom from Bill Gross: “Markets are reaching the point of low return and diminishing liquidity.” I’ll add that it’s really important to Bubble analysis that the ability for central bankers to inflate bond prices has essentially run its course. Low returns on fixed income and virtually no return on savings foster Bubble-inflating flows to equities. But it also ensures that when this Bubble bursts – a global Bubble, in stocks, bonds and asset prices generally, that has made it to the heart of contemporary “money” – there will be limited scope for Financial Sphere reflationary measures. And it’s when confidence falters in “money,” perceived “money-like” instruments and policymaking more generally, that we will come to see clearly that you can’t cure a debt crisis with more debt.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $239bn y-o-y, or 2.1%, to a new seven-month low $11.775 TN. Over two years, reserves were $936bn higher for 9% growth.

Money market fund assets jumped $25.6bn to $2.688 TN. Money Funds were down $31bn y-t-d and dropped $14bn from a year ago, or 0.5%.

Total Commercial Paper gained $4.4bn to a 2014 high $1.096 TN. CP expanded $50bn year-to-date and was up $46bn over the past year, or 4.4%.

Currency Watch:

December 4 – Bloomberg (Ksenia Galouchko, Evgenia Pismennaya and Vladimir Kuznetsov): “Russia is urging exporters such as OAO Rosneft to convert more of their foreign revenue into rubles, a move that Sputnik Asset Management and Bank of America Corp. say is tantamount to capital controls. The government is appealing to state-controlled exporters to help limit the ruble’s tumble, Finance Minister Anton Siluanov told reporters… ‘This is definitely an introduction of capital controls, although in a different sense than the one we’re used to,’ Alexander Losev, the… chief executive officer of Sputnik, said… ‘The sale of foreign-exchange revenue is recommended for those companies whose business depends on or is controlled by the state. Siluanov’s proposal is a classic example of the ‘kind word and pistol’ method.’”

The U.S. dollar index jumped 1.1% to 89.334 (up 11.6% y-t-d). For the week on the downside, the Mexican peso declined 3.0%, the South African rand 2.6%, the Japanese yen 2.3%, the Australian dollar 2.2%, the Norwegian krone 1.8%, the New Zealand dollar 1.7%, the Swedish krona 1.4%, the Singapore dollar 1.4%, the Swiss franc 1.4%, the euro 1.4%, the Danish krone 1.3%, the Brazilian real 0.9%, the Taiwanese dollar 0.6%, the South African rand 0.5%, the British pound 0.4% and the Canadian dollar 0.2%.

December 2 – Wall Street Journal (Ryan Tracy): “The U.S. financial system is growing more vulnerable to debilitating shocks as new regulations and market forces change trading habits and make some market participants less willing to smooth out volatility, a government watchdog warned. The Office of Financial Research, a new arm of the Treasury Department created by the 2010 Dodd-Frank law, said the system is vulnerable to repeats of what occurred in October, when tumult in the trading of U.S. Treasury securities spread broadly to futures, swaps and options markets. ‘Although the dislocation that peaked in mid-October was fleeting, we believe there is a risk of a repeat occurrence,’ the office said…, adding that such volatility ‘raises a host of financial stability concerns.’ …The report said such swings could be exacerbated by computerized trading and algorithms, as high volumes of transactions are executed automatically, deepening instability.”

December 3 – Bloomberg (Lisa Abramowicz): “Banks may have gotten safer since the 2008 credit crisis, but risk is migrating to bond buyers. That’s worrying analysts and policy makers alike, who see investors plowing into infrequently-traded debt while Wall Street reduces its role in making markets. The combination has ‘resulted in a new world for investors,’ one that’s fraught with pockets of less trading and bigger price swings, Royal Bank of Scotland Group Plc analysts wrote… The U.S. Treasury Department has taken note, too, saying this week that investors pose a growing threat to financial stability. ‘Markets have become more brittle because liquidity may be less available in a downturn,’ according to the annual report by the Treasury’s Office of Financial Research. ‘Recent volatility in financial markets focused attention on some of the vulnerabilities that have been growing over the past several years.’”

December 2 – Bloomberg (Katherine Chiglinsky): “U.S. corporate bond sales swelled to an annual record as a late-year rush by borrowers to lock in low interest rates pushed offerings for 2014 pass $1.5 trillion… Internet commerce company Alibaba Group Holding Ltd. sold $8 billion last month, helping propel this year’s volume past the previous high of $1.494 trillion set last year. Companies have offered $1.168 trillion of investment-grade notes in 2014 and $344 billion of junk bonds… That outpaces the $1.146 trillion of high-grade notes and $348 billion of junk notes issued last year…”

December 2 – Bloomberg (Nabila Ahmed and Sridhar Natarajan): “Bond investors who helped finance America’s shale boom are facing potential losses of $8.5 billion as oil prices plummet by the most since the financial crisis. The $90 billion of debt issued by junk-rated energy producers in the past three years has fallen almost 10% since crude oil peaked in June… The oil selloff is deepening concern among bond investors that the least-creditworthy oil explorers will struggle to pay their obligations and prompt bankers to rein in credit lines as revenue slumps.”

December 2 – Bloomberg (Darrell Preston): “The agency that financed stadiums for three of Houston’s professional sports teams is selling debt to extricate itself from municipal-bond deals that backfired with the financial crisis. The Harris County-Houston Sports Authority plans to borrow about $689 million starting this week to restructure some of its $1 billion of obligations. The debt, mostly backed by tourism- related taxes, was sold to pay for facilities in the fourth- most-populous U.S. city for Major League Baseball’s Astros, the National Basketball Association’s Rockets and the National Football League’s Texans. Localities are still dealing with financing structures sold by Wall Street banks more than a decade ago with the promise of cutting borrowing costs.”

U.S. Bubble Watch:

December 3 – Reuters (Kristen Hays): “Plunging oil prices sparked a drop of almost 40% in new well permits issued across the United States in November, in a sudden pause in the growth of the U.S. shale oil and gas boom that started around 2007. Data provided exclusively to Reuters… by industry data firm Drilling Info Inc showed 4,520 new well permits were approved last month, down from 7,227 in October. The pullback was a ‘very quick response’ to U.S. crude prices…, said Allen Gilmer, chief executive officer of Drilling Info. New permits, which indicate what drilling rigs will be doing 60-90 days in the future, showed steep declines for the first time this year across the top three U.S. onshore fields: the Permian Basin and Eagle Ford in Texas and North Dakota's Bakken shale.”

December 5 – Financial Times (Eric Platt): “Bullish equity investors have company. With stocks loitering in record territory, corporate America remains a major buyer of shares. One of the primary drivers of the ageing US bull market — share buybacks and dividend payouts — has hit the accelerator during the third quarter… Management teams have dedicated nearly $900bn to both forms of returns over the past 12 months, estimates from S&P Dow Jones Indices show… Companies have been a key source of support in recent years as investors have stepped back from buying equities. Since the start of 2010, companies have spent $3.3tn on share buybacks and dividends… During the third quarter, companies spent roughly $238bn on dividends and buybacks, with the latter making up nearly 63% of the total. The preliminary figure ranks second only to the first quarter of 2014, when company expenditures on the two reached $241.2bn.”

Federal Reserve Watch:

December 1 – Reuters (Jonathan Spicer and Ann Saphir): “With the U.S. economy humming along at its fastest clip in more than a decade, the Federal Reserve should be confident about its ability to weather a global slowdown and start lifting interest rates around the middle of next year. But then there is inflation. Interviews with Fed officials and those familiar with its thinking show the mood inside is more somber than the central bank's reassuring statements and evidence of robust economic health would suggest. The reason is the central bank's failure to nudge price growth up to its 2% target and, more importantly, signs that investors and consumers are losing faith it can get there any time soon… Barring a turnaround, Fed officials would hesitate to raise interest rates as soon as mid-2015 even as gradually as their forecasts now suggest… ‘The primary concern at the moment is whether you can get back to 2% in a way that keeps expectations anchored, and maintains the credibility of the Fed as an institution that can achieve its goal,’ said Jeffrey Fuhrer, the Boston Fed's senior policy advisor.”

December 1 – Bloomberg (Craig Torres): “Alarms went off inside the Federal Reserve: the Fed’s innermost secrets had leaked to Wall Street. Confidential deliberations of the Federal Open Market Committee made their way into a research note circulated among traders. The report -- a fly-on-the-wall account of the FOMC’s September 2012 meeting, with hints of Fed action to come that December -- prompted a mole hunt that reached the highest levels of the central bank. The story of the FOMC leak underscores the lengths to which outsiders will go to penetrate the inner workings of the Fed, and how valuable access can be. The Fed has never disclosed the investigation or its findings. Public pronouncements by Fed leaders routinely move markets, and officials must walk a delicate line when discussing information. They are allowed to air their own views but are forbidden from disclosing non-public information about committee decisions.”

ECB Watch:

December 4 – Reuters (John O’Donnell and Reinhard Becker): “The European Central Bank will decide early next year whether to take further action to revive the euro zone's economy, its president said on Thursday, signalling that he would not allow opposition from Germany or anyone else to stop it. In his clearest language yet, Mario Draghi underlined the central bank's commitment to supporting the ailing economy of the 18-country bloc, and argued the case for printing fresh money to buy assets such as state bonds. But his remarks, which came within minutes of a meeting where he clashed with German officials over his ambitions, set him on a possible collision course with the euro zone's biggest and single most important country.”

December 5 – Financial Times (Claire Jones): “Mario Draghi, European Central Bank president, has maintained he can deliver a fresh package of measures to stave off economic stagnation in the eurozone next year, despite renewed signs of tensions between policy makers at the central bank. Old wounds between governing council members were reopened on Thursday, after splits emerged over a slight toughening up of the language on plans to swell the ECB’s balance sheet by around €1tn… The ECB strengthened its forward guidance by saying the central bank ‘intends’ to expand its balance sheet to around €3tn to boost inflation, rather than simply ‘expecting’ to meet this objective. But the semantic change was not unanimous, with dissent coming from members of the executive board of top ECB officials, as well as some national central bank governors.”

December 5 – Reuters (Paul Carrel and John O'Donnell): “The head of Germany's Bundesbank warned the European Central Bank on Friday against copying the money printing used in the United States and Japan, saying that it would not have the same impact in Europe. Speaking a day after ECB President Mario Draghi signalled further action to shore up the euro zone economy as soon as early next year, Jens Weidmann cautioned that so-called quantitative easing may not work in Europe. ‘You cannot simply apply the same formula in Europe that has enjoyed success in the U.S.  or in Japan,’ Weidmann told a conference… Weidmann and fellow German ECB policymaker Sabine Lautenschlaeger opposed Thursday's ECB decision to firm up language on the expansion of the bank's balance sheet, central bank sources said. Weidman's comments on Friday followed German Finance Minister Wolfgang Schaeuble saying expansive monetary and fiscal policies were a cause of economic problems, not a solution to them. Commenting on the idea that economic weakness required an expansive monetary and fiscal policy, Schaeuble said: "I am not convinced of this. Rather, I am of the view that this approach is not the solution, rather the cause (of economic woes).’”

December 4 – Bloomberg (Jana Randow and Jeff Black): “The European Central Bank’s Governing Council expects to consider a package of broad-based asset purchases including sovereign debt next month… While the proposal is envisaged to include various types of bonds, it won’t encompass equities, said the officials, who asked not to be identified… They said no decision on implementing quantitative easing has been taken yet, and the composition of the program may be influenced by incoming data… ECB President Mario Draghi said… that policy makers ‘won’t tolerate’ a prolonged period of low inflation, and that officials discussed ‘all assets but gold’ as potential targets for purchases.”

Russia/Ukraine Watch:

December 6 – Bloomberg (Ye Xie and Krystof Chamonikolas): “Russia’s currency and bond rout is spreading to former Soviet states. Currencies are tumbling after holding steady since President Vladimir Putin annexed Crimea in March. Russia’s deepening crisis and the ruble’s 34% slump over the past six months hurt economies that rely on remittances and imports from the country. Georgia’s lari lost 10% against the dollar last week… The Armenian dram slumped 2.8%, the sixth weekly drop, the longest slump since March 2010. Kazakhstan’s dollar-denominated notes due in 2024 slid, sending yields up 57 bps… to 4.76%.”

December 5 – Bloomberg (Ilya Arkhipov): “The U.S. and its allies are seeking to change the regime in Moscow through sanctions and attacks on the ruble and the oil price, Russia’s spy chief said. A decline of more than 30% in the oil price this year is caused partly by U.S. actions, Mikhail Fradkov, the head of the Foreign Intelligence Service, said after President Vladimir Putin’s annual address to parliament. Foreign investment funds are ‘taking part’ in ruble speculation via intermediaries, Fradkov, a former prime minister, said… ‘Any speculation has specific schemes and the schemes have a number of participants,’ he said… The U.S. and its allies want to oust Putin from power and achieve regime change, Fradkov said. ‘Such a desire has been noticed, it’s a small secret’ he also told reporters. ‘No one wants to see a strong and independent Russia.’”

December 3 – Bloomberg (Jason Corcoran, Lyubov Pronina and Natasha Doff): “State-controlled VTB Bank bonds sank below 72 cents on the dollar on concern that falling oil and a weakening ruble are straining Russian lenders’ finances. Sergey Dubinin, chairman of VTB’s supervisory council, underscored the anxiety by saying Russia’s banking system is experiencing ‘some panic.’ The ruble drop and four interest-rate increases this year are a ‘bad combination’ for growth and lenders, he said…”

December 2 – Bloomberg (Olga Tanas): “Russia is entering its first recession since 2009 as sanctions over the Ukraine conflict combine with plunging oil prices and the weakening ruble to hammer the economy and force the government to prop up banks. Gross domestic product may shrink 0.8% next year, compared with an earlier estimate of 1.2% growth, Deputy Economy Minister Alexei Vedev told reporters…”

Brazil Watch:

December 3 – Bloomberg (Sabrina Valle): “Brazil’s biggest money laundering and corruption scandal just got bigger with a high-level executive’s pledge to return $100 million and testify against colleagues including his former boss at state-run Petroleo Brasileiro SA. Pedro Barusco, a third-tier executive who reported to the head of the engineering division until 2010, contacted prosecutors and confessed he took bribes from construction companies… The testimony from Barusco threatens to implicate more people in the scandal as prosecutors probe the origins of his allegedly ill-gotten fortune. Petrobras management has been dealing with the crisis as it struggles to meet output targets and the industry adjusts to the lowest crude prices since 2009. It has put President Dilma Rousseff, who was Petrobras chairwoman from 2003 to 2010, on the defensive after she narrowly won re-election in October.”

December 4 – Wall Street Journal (Will Conners): “Moody’s… said Wednesday it downgraded the baseline credit of Petroleo Brasileiro SA, the second downgrade of Brazil’s state-controlled oil company in two months and the latest in a series of setbacks for the company as it grapples with a corruption scandal.”

December 3 – Bloomberg (Raymond Colitt and David Biller): “A 30 billion-real ($11.7bn) credit from Brazil’s Treasury to the national development bank, BNDES, raises doubts over the government’s fiscal policy objectives, Banco Mizuho’s chief Brazil strategist said. The government authorized the Treasury to transfer the amount to the… lender to finance the purchase of equipment and machinery, outgoing Finance Minister Guido Mantega told reporters… The transfer comes a week after incoming Finance Minister Joaquim Levy cautioned that an increase in funding to the BNDES could jeopardize his plans to reduce gross debt as a percentage of gross domestic product. Today’s credit announcement sends the wrong sign to investors hoping for a cut in government spending…, said Luciano Rostagno, chief strategist at Banco Mizuho do Brasil SA. ‘It raises doubts about the government’s willingness to do a serious fiscal adjustment,’ Rostagno said… ‘It’s definitely not a good sign.’”

December 4 – Bloomberg (Mario Sergio Lima and Raymond Colitt): “Brazil’s central bank doubled the pace of its interest rate increase as the government seeks to persuade investors it’s committed to containing inflation that has exceeded its target for more than four years. The bank’s board… raised the benchmark Selic by half a point to 11.75% after a 25 bps increase Oct. 29… Policy makers said future rate increases will probably be conducted with ‘parsimony.’”

December 1 – Bloomberg (Julia Leite and Paula Sambo): “Companies in Brazil are missing out on a global surge in bond sales as a stalled economy and a growing corruption investigation push up borrowing costs. Corporate borrowers have raised $5.8 billion selling bonds internationally since June, 43% less than the same period last year. That compares with a 10% increase for dollar issuance in all emerging markets. For the second half of the year, Brazilian companies are poised to issue the fewest bonds since the financial crisis of 2008. Yields on the nation’s corporate bonds are rising more than twice as fast as those in developing countries as analysts forecast growth will lag behind the average for Latin America for a fourth straight year.”

EM Bubble Watch:

December 2 – Bloomberg (David Yong): “Losses in emerging market distressed debt have mounted to the worst since the global financial crisis led by Indonesian coal miner PT Bumi Resources and ZAO Russian Standard Bank. Bank of America Merrill Lynch’s distressed emerging markets corporate index tumbled 2.7% yesterday after a 5.6% drop in November. The gauge, which tracks 108 dollar-and euro-denominated debentures from Russia to China and Brazil, has retreated 9.8% this year, the most since a 36.8% slide in 2008. A glut in coal and iron ore, plunging oil prices and sanctions against Russia are pushing more companies to the brink of default. Hedge funds are shutting at a rate not seen since the credit crunch amid disappointing returns… ‘It’s a very bloody environment for most of the small- and mid-sized commodity players,’ Heo Joon Hyuk, the… head of global fixed income at Mirae Asset Global Investments Co., said… ‘And Russian corporates have one more burden above falling commodities -- funding restrictions.’”

December 2 – Bloomberg (Sebastian Boyd and Christine Jenkins): “OPEC’s refusal to cut oil production is increasing the chances Venezuela will have to devalue its currency and sell its U.S.-based oil unit to avoid a default, according to EMSO Partners Ltd. and EM Quest Capital. The country’s benchmark notes due 2027 sank to a five-year low of 51.6 cents on the dollar… as the decision of the Organization of Petroleum Exporting Countries on Nov. 27 to maintain output deepened a collapse in the price of oil, which accounts for 95% Venezuela’s export revenue.”

December 1 – Bloomberg (Brendan Case and Eric Martin): “President Enrique Pena Nieto’s approval rating plunged to the lowest level since he took office two years ago, dragged down by drug-related violence and sluggish economic growth, according to two opinion polls. Thirty-nine percent of those polled approved of Pena Nieto’s performance, the least for any Mexican president since the mid-1990s and down 11 percentage points from August… On the economic front, the Finance Ministry and central bank cut their 2014 growth forecast ranges last month after Mexico’s expansion missed analysts’ estimates for the eighth time in 10 quarters.”

December 3 – Bloomberg (Selcan Hacaoglu): “Turkish consumer price inflation accelerated more than anticipated in November, giving the central bank leeway to resist government pressure to cut interest rates. The annual inflation rate rose to 9.2% from 9% in the previous month…”

December 3 – Bloomberg (Patrick Donahue): “China and Turkey are among countries that tumbled the most in a global corruption ranking as they displayed widespread or increased levels of bribery, graft and opacity, Transparency International said. China fell to 100th place on the list, down from 80th last year, the watchdog group said in its annual Corruption Perceptions Index. Turkey slid to 64th place from 53rd in 2013. Egypt and Afghanistan gained in the ranking, which places the least corrupt countries at the top.”

December 4 – Bloomberg (Herdaru Purnomo): “Indonesia’s capital is girding for a potential turnout of millions of protesters asking for a bigger increase in minimum wages in the world’s fourth most-populous nation, a test of President Joko Widodo’s pro-business image. The two-day national protest, starting Dec. 10, will involve four trade union groups… Workers have seven demands including renegotiating last month’s minimum-wage deal and scrapping outsourcing in state-owned companies, he said.”

December 4 – Bloomberg (Paul Wallace): “South Africa’s worsening government finances are pushing the nation’s credit rating closer to junk, Fitch Ratings Ltd. said… Moody’s… downgraded South Africa to Baa2, the second-lowest investment grade and a similar level to Fitch, on Nov. 6. Standard & Poor’s downgraded it to BBB-, the lowest investment grade, in June. ‘Public finances in South Africa, which used to be a relative rating strength, no longer are,’ Richard Fox, head of Middle East and Africa sovereign ratings at Fitch, said… The country was ‘barely keeping pace with the BBB peer group’ in terms of gross domestic product per person…”

Europe Watch:

November 28 – Financial Times (Steve Johnson): “The German fund industry has witnessed its strongest inflows for 14 years during the first nine months of 2014. The strong demand comes despite the backdrop of a sluggish economy, with growth virtually grinding to a halt in the third quarter of the year, although this has propelled the bond market to new highs as yields on 10-year sovereign debt have tumbled to just 0.7%, from 1.94% at the turn of the year. Net inflows reached €71.2bn in the nine months to end of September, the highest tally since the €76.1bn raised at the height of the technology bubble in 2000… The bulk of the money went into so-called spezialfonds, aimed at institutional investors, with insurance companies, in particular, putting more money to work.”

Global Bubble Watch:

December 4 – Financial Time (Anjli Raval): “The flow of Opec petrodollars into global financial markets is set to dry up as the collapse in the oil price delivers a $316bn hit to the cartel’s revenues. Big oil producers have pumped the windfall they enjoyed from soaring oil prices over the last decade into a huge range of global assets, from US Treasuries and high-grade corporate bonds to equities and real estate. Qatar, for example, bought the Harrods department store and Paris Saint-Germain, France’s top football club, while Abu Dhabi’s sovereign wealth fund bought a stake in the glitzy Time Warner building in New York. The flow of petrodollars into the global financial system boosted liquidity, spurred asset prices and helped to keep borrowing costs down. But the 40% fall in Brent crude since mid-June will reverse this trend, as the shrinkage of the oil producers’ cash pile removes a pillar of support for global markets. ‘This is the first time in 20 years that Opec nations will be sucking liquidity out of the market rather than adding to it through investments,’ David Spegel, global head of emerging market sovereign and corporate research at BNP Paribas.”

December 3 – Bloomberg (Katherine Chiglinsky and Sridhar Natarajan): “Corporate bond sales worldwide are poised to set an annual record as soon as this week as companies lock in borrowing costs that forecasters say are bound to rise. Amazon.com Inc., Volkswagen AG and Alibaba Group Holding Ltd. have propelled offerings to $3.96 trillion this year, about $7 billion short of the peak of $3.97 trillion in 2012… Company bond sales in the U.S. have already set annual records… Borrowers from the most-creditworthy to the neediest have benefited as corporate yields also declined. Globally, corporate bonds now yield just 2.7%, within 0.2 percentage point of its record low last year… Since 1996, yields have averaged about 4.7%. In the U.S., home to the world’s biggest corporate bond market, borrowers have issued $1.5 trillion of debt… Investment-grade companies have already sold a record $1.18 trillion of bonds. Corporate bond issuance is also booming in Europe, with sales of 846 billion euros ($1 trillion) this year, up from 760 billion euros in all of 2013 and the most since 2010… Average yields on investment-grade bonds in euros fell 0.9 percentage point this year to 1.2%, 0.04 percentage point from a record low reached last month… Those on junk-rated debt dropped 0.3 percentage point to 3.98% versus the five- year average of 7.2%.”

December 4 – Financial Times (Stephen Foley): “An annus horribilis for US active fund managers drove a further $21.3bn into Vanguard, the leading provider of low-cost index tracker funds, in November. The inflows, the mutual fund giant’s third-best monthly total, means the… company has brought in $185bn into its US mutual funds in 2014, an industry record… Vanguard has had some powerful additional tailwinds this year, because active managers are underperforming their benchmarks to a greater degree than for more than a decade… Vanguard… overtook Pimco last year to become the second-largest fund manager in the world, behind BlackRock, and the latest three months of inflows have taken its assets under management comfortably above $3tn.”

December 1 – Bloomberg (Katherine Burton): “Hedge funds are shutting at a rate not seen since the financial crisis, as many managers post disappointing returns and the largest players dominate money raising… In the first half of the year, 461 funds closed, …Hedge Fund Research Inc. said. If that pace continues, it will be the worst year for hedge fund closures since 2009, when there were 1,023 liquidations… Hedge funds, on average, have returned just 2% in 2014, their worst performance since 2011… Smaller funds have struggled to grow as institutional investors flocked to the biggest players. In the first half of 2014, 10 firms… accounted for about a third of the $57 billion that came into the industry.”

Geopolitical Watch:

December 2 – Bloomberg (Michael Riley and Jordan Robertson): “Hackers working for Iran have targeted at least 50 companies and government organizations, including commercial airlines, looking for vulnerabilities that could be used in physical attacks, cyber-security firm Cylance Inc. said… The hackers infiltrated the computer systems of carriers and their contractors in Pakistan, the United Arab Emirates and South Korea, the Irvine, California-based firm said in a report outlining the results of a two-year investigation. They broke into the computers of suppliers responsible for aircraft maintenance, cargo loading and refueling, according to the report and Cylance analysts, and stole credentials that could be used to impersonate workers. In the U.S., computers belonging to chemical and energy companies, defense contractors, universities and transportation providers were hacked in what Cylance dubbed Operation Cleaver… The capabilities of Iranian cyberspies have advanced to the point that the country is quickly becoming a top-tier cyber power, according to the report.”

China Bubble Watch:

December 1 – Bloomberg: “A Chinese manufacturing gauge fell as factory shutdowns aggravated a pullback in the economy, raising pressure on the central bank to ease policy further after it lowered interest rates for the first time in two years. The government’s Purchasing Managers’ Index fell to an eight-month low of 50.3 in November, compared with… October’s 50.8… China’s central bank cut interest rates last month as the economy heads for its slowest full-year expansion since 1990.”

December 5 – Bloomberg: “Passenger-vehicle sales in China rose at a slower pace last month as inventory levels climbed in the world’s largest auto market. Retail deliveries of cars, multipurpose and sport utility vehicles climbed 5% to 1.71 million units in November… That compares with the 9.3% growth rate in October. Dealers are cutting prices to reach targets set by automakers to qualify for year-end bonuses… A measure of vehicle inventory rose to the highest level this year last month… ‘There are more and more auto dealers selling vehicles at losses as they struggle to keep afloat,’ said Wang Ji, a… director at the dealer chamber of commerce. ‘Overcapacity is the fundamental reason behind the production surplus and unless they fix it, there will be a reshuffle of auto dealers and automakers sooner or later.’”

December 2 – Bloomberg: “China is tightening checks on local bond sales in its latest bid to reduce risks as debt loads surge to a record amid slowing economic growth. Underwriters must provide audit reports on local government financing vehicles, or the region in which they’re located… China’s leaders are trying to limit risks at the fundraising units, which cities and towns rely on to bankroll construction projects, after they sold a record 1.5 trillion yuan ($244 billion) of notes this year. Authorities are considering requiring provincial governments shift toward direct municipal debt sales as they aim to cut reliance on LGFVs, a draft plan from the Ministry of Finance showed in October.”

December 5 – Bloomberg: “Investors must consider risks while putting money into stocks, China’s securities regulator warned today after a buying spree drove daily trading turnover to above 1 trillion yuan ($163bn) for the first time. Illegal activities including stock manipulation have recently been ‘raising their head’ and investors should invest rationally, Deng Ge, a spokesman for the China Securities Regulatory Commission, said…”

December 2 – Bloomberg: “Chinese banks’ lending numbers understate their exposure to the property market, where a downturn persisting for ‘at least’ one or two years will add to credit risks, Standard & Poor’s said. Loans to property development and construction were at least 8.2 trillion yuan ($1.3 trillion), or 13.8% of total advances, at the end of last year… That compared with the 7 trillion yuan reported by banks, the ratings agency said… Shadow banking, where lenders can move credit exposures off their balance sheets, has helped hold down reported property loans, Liao Qiang, a Beijing-based analyst for the company, said… About 30% to 40% of corporate loans in China are backed by property and land as collateral, S&P said, adding that flat or falling real-estate valuations can significantly hinder borrowers’ ability to renew funding.”

Japan Bubble Watch:

December 5 – Wall Street Journal (Takashi Nakamichi): “A Bank of Japan board member made clear Thursday that the split among the central bank’s decision makers runs deeper than the relatively unified front portrayed by Gov. Haruhiko Kuroda. Takehiro Sato expressed concerns over possible fallout from the central bank’s aggressive government debt purchases, and questioned Mr. Kuroda’s view that the central bank has the power to generate 2% inflation and must commit itself to achieving the goal by around next year. ‘Prices reflect the temperature of the economy, not a variable that can be directly controlled by a central bank,’ Mr. Sato told business leaders… ‘I have a feeling that it is unreasonable to rigidly think that it is necessary to aim at a specific inflation rate within a specific time frame,’ said Mr. Sato, one of the BOJ’s nine policy board members… Mr. Sato also called a weakening yen a ‘risk’ and ‘headwind’ against the Japanese economy, distancing himself from Mr. Kuroda’s generally positive assessment of the falling currency."

December 5 – Wall Street Journal (Tatsuo Ito): “Former senior officials of the Bank of Japan are expressing alarm over the Bank of Japan’s ratcheting up of easing measures, breaking the general silence on policy matters expected from officials who have left the central bank. The comments from the former officials indicate that concern among people with a link with the bank is not limited to the four board members who voted against the expansion of the BOJ’s asset-buying orchestrated by Gov. Haruhiko Kuroda at the end of October. ‘The current easing policy is like a car driving down the highway without brakes,’ said a former policy board member. ‘And that car has just been needlessly filled up with extra gas,’ the former member added… The former officials are becoming increasingly concerned about the potential danger of Mr. Kuroda’s whatever-it-takes approach to hit a 2% inflation target in a two-year time frame.

December 2 – Financial Times (Ben McLannahan): “The government of Japan is now a riskier borrower than either China or South Korea, according to Moody’s, which has put its sovereign credit rating on a par with Bermuda, Oman and Estonia. Monday’s single-notch downgrade for Japan from Aa3 to A1, the fifth-highest rating, represents the first reaction by a big credit rating agency to the decision last month by Prime Minister Shinzo Abe to call a snap election to push back a second scheduled increase in sales taxes… Last month the central bank bought Y11.2tn ($94bn) of government bonds… – more than the total net issuance of Y10.7tn by the finance ministry. This ‘unorthodox’ policy carries risks of a market malfunction, Mr Byrne of Moody’s said, citing fears expressed by BoJ board members as the bank prepared to ramp up annual bond purchases from Y50tn to Y80tn on October 31. ‘It is like any medical treatment. You expect the patient to recover, but there could be adverse side effects,’ he said.”

Disclaimer:

Doug Noland is not a financial advisor nor is he providing investment services. This blog does not provide investment advice and Doug Noland's comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. The Credit Bubble Bulletins are copyrighted. Doug's writings can be reproduced and retransmitted so long as a link to his blog is provided.